What are Convertible Debentures & Bonds?
Convertible debentures are debt instruments that can be changed into equity shares of the company at a future date.
This security also has types of both debt and equity.It rewords periodic coupon/interest just like any other debt mechanism till conversion.
And, at a pre-defined time, this debt mechanism may get transformed into equity shares. These debentures may be of diverse kinds:
Fully convertible debentures (FCD) : where the whole face value of the debenture is transformed into equity shares
Partly convertible debentures (PCD) : where a part of the debenture is transformed into equity
The non-convertible part continues to stand as debentures, make interest income and gain repaid on redemption.
Optionally convertible debentures : OCDs were convertible into equity shares at the consideration of the debenture holders, who may choose to convert them into equity, or continue to holdthe tool as debt depending on their wish and the terms of conversion.
* The issuer specifies the details of the conversion at the time of making the issue itself. These will generally include:
* Date on which or before which the conversion may be made
* Ratio of conversion i.e. the investor who have the number of shares will be eligible to get for each debenture.
* Price at which the shares will be allotted to the investor on conversion. generally, this is at a discount to the market price.
* Proportion of the debenture that will be converted into equity shares (in case of partially convertible debentures)
The advantage to the issuer of convertible debenture lies in the information that convertible debentures usually have a lower coupon rate than pure debt instruments.
This is for the reason that the yield to the investor in such debenture is not from the coupon alone but also the possibility of capital appreciation in the investment once the debentures are converted into equity shares.
Furthermore, the issuer does not have to repay the debt on maturity since shares are issued in lieu of repayment.
The Limitations to this is that stakes of the existing shareholders get weaken when fresh shares were issued on conversion.
When more shareholders come in, the proportionate holding of existing shareholders drop.The investors in a convertible debenture have the benefit of equity and debt characteristics.
They earn coupon income in the preliminary stage, usually when the company’s project is in its budding stage.And, once the debenture is converted into shares, they may gain from the appreciation in the value of the shares.